Another US Credit Downgrade Likely

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Another credit rating's agency could downgrade U.S. credit by the end of the year, according to a report by Bank of America Merrill Lynch. An expected failure from the Joint Select Committee on Deficit Reduction, or “supercommittee,” was the main reason for the potential downgrade. U.S. credit was already downgraded by Standard & Poor's in August.

“The credit rating agencies have strongly suggested that further rating cuts are likely if Congress does not come up with a credible long-run plan,” Ethan Harris, chief economist and primary author of the report, wrote.

As part of the Budget Control Act of 2011 passed by Congress in August, the 12-member supercommittee is currently trying to craft a bill that would reduce budget deficits by at least $1.2 trillion over the next 10 years.

Recent news reports suggest that the supercommittee is currently at an impasse over which baseline they should use to calculate the deficit reduction, and whether the package will include revenue increases.

Some committee members want to use the baseline used by the Congressional Budget Office. It assumes that Medicare doctor payment cuts, passed under the Affordable Care Act, will go into effect and the Bush-era tax cuts, extended under Obama in 2010, will expire. Many expect Congress, however, to revoke the doctor payment cuts and extend some or all of the Bush-era tax cuts. The difference between the two baseline assumptions is about $5 trillion.

The other major sticking point in the supercommittee is over revenue increases and reducing the growth in entitlement spending (Social Security, Medicare, and Medicaid). Republicans want all of the savings to come from spending cuts, with no additional sources of revenue. Democrats do not want to reduce entitlement spending without revenue increases.

Due to the seemingly intractable positions of the two sides on the supercommittee, Harris believes that the supercommittee will not come to an agreement by its Nov. 23 deadline and U.S. credit will be downgraded as a result.

“We expect at least one credit downgrade in late November or early December when the supercommittee crashes,” Harris wrote.

If the supercommittee fails to come up with a bill that is passed by Congress, $1.2 trillion of automatic spending cuts, mostly in defense, will go into effect. The nature of these cuts would be a net drain on the economy, according to Harris.

Moody's Analytic Services and Fitch Ratings are the other two bond ratings services that could downgrade U.S. debt from AAA. Both agencies have said that a failure to reach an agreement by the supercommittee would factor into future debt rating decisions.

The U.S. national debt is almost $14.9 trillion with over $116 trillion in unfunded liabilities.